Can Income Tax Dept Withhold Tax Refund Without Proven Liability? Calcutta HC Clarifies

In a significant pushback against unexplained withholding of tax refunds, the Calcutta High Court has held that the Income Tax Department cannot invoke Section 245 unless it proves that a taxpayer actually owes money. The ruling came after a Kolkata-based taxpayer challenged the Tax Department’s decision to retain a sizeable portion of his refund without citing any valid demand.

The Case: Rajneesh Agarwal vs ITO (2025, Calcutta High Court)

The petitioner (Mr. Agarwal) filed his ITR for Assessment Year (AY) 2018-19, declaring net income and tax payable. Due to TDS (Tax Deducted at Source), more tax was deducted than his actual tax liability - making him eligible for a refund.

Initially, after assessment under Section 143(1), a net tax payable amount was shown (i.e., a refund was not granted immediately). Subsequently, by an order under Section 154 (rectification), the Tax Department determined that, in fact, a substantial refund (gross) was due - Rs 55,54,357.

“Out of this, the Tax Department withheld Rs 22,73,833, citing Section 245. The net refund paid was far less (only part of the amount). The taxpayer challenged the withholding on grounds that the Tax Department did not show any valid outstanding demand or tax liability warranting adjustment; no explanation or demand notice was provided,” informs Rajarshi Dasgupta, Executive Director - Tax, AQUILAW.

He made written communications, filed a rectification request, and even attempted a writ petition earlier (which was withdrawn on assurances), but the Tax Department provided no statutory justification or demand details even later. Finally, he filed a fresh writ petition. The High Court took up the matter.

Decision Of The Calcutta High Court - The Court’s Reasoning And Stand

The Calcutta High Court - through a Bench of its judges - gave a clear ruling in favour of the taxpayer.

The Court emphasised that while Section 245 does allow set-off of refund against tax payable, such power is conditional. The conditions include — there must be an existing/quantifiable “sum … remaining payable” (i.e., outstanding demand), and there must be an intimation to the assessee about the intention to set off.

“In the present case, the Tax Department failed to demonstrate that any valid outstanding liability or demand existed; it also did not show that there was any statutory provision or order making tax payable by the petitioner; there was no independent demand notice or recovery process initiated,” says Dasgupta.

The Court observed that withholding a refund in the absence of any valid demand or liability - purely on a speculative or precautionary basis - is not permitted under law. That would amount to unlawful retention of the taxpayer’s money.

Given this, the Court held that the withholding of Rs 22,73,833 was legally unsustainable. It directed the Tax Department to release the withheld amount along with applicable interest (as per law) within 10 weeks.

The writ petition was, therefore, allowed; the Tax Department’s reliance on Section 245 in this case was invalid because it had not established any tax liability warranting set-off.

What Does Section 245 Of The I-T Act, 1961 Provide?

According to legal and tax experts, Section 245 of the Income‑Tax Act, 1961, allows the tax authorities to “set off” a refund due to a taxpayer against any outstanding tax liability that the taxpayer has. In effect, instead of paying you a refund, the Tax Department may apply (offset) that refund, or part of it, against “any sum … remaining payable under this Act by the person.”

The law requires that before such a set-off, the Tax Department must issue an intimation in writing to the taxpayer, notifying them that it proposes to exercise this set-off.

(After recent amendments) There is also a provision under Section 245(2) that - in cases where assessment or re-assessment proceedings are pending - the authorities may withhold the refund (even without immediate set-off), if they conclude that granting the refund may adversely affect revenue. This too must be based on “reasons recorded in writing,” and requires prior approval of higher authorities (like the Commissioner).

In short: “Section 245 gives the Tax Department conditional power to adjust or withhold a refund - but only if there is a valid outstanding demand (or pending assessment in certain cases) and proper procedure (intimation / recording of reasons) is followed,” observes Dasgupta.

Thus, Section 245 does not grant a carte-blanche to block or keep refunds for an indefinite time; its scope is legally circumscribed.

Practical Implications Of The Ruling

The HC ruling reinforces that Section 245 is not a blanket tool that allows the Tax Department to withhold refunds without justification. It must demonstrate real, established tax liability or demand to justify any offset or withholding.

Taxpayers whose refunds have been withheld under Section 245 can - if there is no valid demand or notice - challenge the withholding. The Court’s judgment provides a strong precedent for such challenges.

“The decision stresses procedural fairness: intimation, recording of reasons, and genuineness of demand remain essential. Arbitrary or precautionary withholding violates legal and constitutional principles (e.g., no recovery/collection without law),” says Dasgupta, adding that for future assessments, it sends a message to authorities: where a refund is due and no valid demand exists, they can’t withhold merely to “keep in abeyance” the refund. This helps protect taxpayer rights.